On 18 September 2018 the OECD published comments received on its discussion draft on financial transactions in relation to BEPS actions 8 to 10 (ensuring that transfer pricing outcomes are in line with value creation).

Discussion draft

The discussion draft was issued on 3 July 2018 as part of the follow-up work on the transfer pricing aspects of financial transactions requested by the 2015 BEPS report. The draft aimed to clarify the application of BEPS principles to financial transactions as set out in the 2015 BEPS report on actions 8 to 10. The draft was concerned with the accurate delineation of financial transactions and factors specific to financial transactions that need to be taken into account in delineating the transaction. The draft considered situations in which a lender would be allocated risks with respect to an advance of funds within a multinational group.

The draft noted that where the accurate delineation of the actual transaction shows that a funder lacks the capability, or does not perform the decision-making functions, to control the risk associated with investing in a financial asset, it will be entitled to no more than a risk-free return as an appropriate measure of the profits it is entitled to retain. In practice the interest rate on certain government issued securities is often used as a reference rate for a risk-free return, as these securities are generally considered by market practitioners not to carry significant default risk. Other alternatives may be considered on prevailing facts and circumstances of each case and interested parties were invited to describe financial transactions that may be considered as realistic alternatives to government issued securities to approximate risk-free rate of returns.

The draft also noted that where a party providing funding exercises control over the financial risk associated with the provision of funding, without the assumption of, including the control over, any other specific risk, it could generally only expect a risk-adjusted rate of return on its funding. Generally the expected risk-adjusted rate of return on a funding transaction can be considered to have two components, these being the risk-free rate and a premium reflecting the risks assumed by the funder. The risk-adjusted rate of return can be determined under a number of different approaches, for example based on the return of a realistic alternative investment with comparable economic characteristics. Commentators were invited to comment on the guidance on determining the rate of return.

The draft also looked at specific issues such as the treasury function, intra-group loans, cash pooling, hedging, guarantees and captive insurance.

Comments received

A number of commentators point out that a clear international framework needs to be established in this area to avoid tax disputes and mutual agreement procedure cases. Detailed guidance and examples will therefore be required to minimize the possibility of disputes in this complex area of transfer pricing. Consensus must be achieved among the international community on the way forward as there will be more tax disputes if certain members of the Inclusive Framework take a separate approach. Most commentators are in favour of adherence to the arm’s length principle in relation to financial transactions as the introduction of any alternative approach would increase the danger of double taxation and the possibility of tax disputes. If there is no worldwide consensus on these issues there may need to be a supplementary form of arbitration such as arbitration to resolve issues.

The BEPS Monitoring Group however commented on the resources needed to separately examine each financial transaction as this would require specialist industry knowledge. Most tax authorities throughout the world do not have this type of specialist knowledge. For the taxpayers the documentation of transfer pricing for financial transactions is very expensive. Therefore in their view simplified methods are needed that would give fair results for taxpayers and tax authorities. The OECD could take the lead in suggesting such methods and issuing guidance on them.

Some commentators want more clarity on dealing with situations where the taxpayer’s credit rating is different to the credit rating of the group to which the taxpayer belongs. This could give rise to disputes and needs clear and detailed guidance from the OECD.